Corporate pension plans are often advised that because their liabilities are discounted with corporate bond yields, the best hedge of their liabilities is corporate bonds. While we are certainly fans of long credit within LDI allocations, we believe the aforementioned advice is deficient.
Defined benefit (DB) plans occasionally resort to tricks, incorporating various financial practices that sound like they should work, but in actual practice may fail to meet your plan’s goals. This update explores some of the gimmicks that DB plans may pursue, and why your plan should avoid them.
Sluggish stock market returns in 2015 resulted in corporate DB plans losing funded status. While stock market returns rebounded strongly in 2016, funded status generally declined further, thanks to sharp drops in long-term corporate yields that drove up liability valuations.
Sometimes LDI options have hedge ratios in excess of 100%, which is necessary to fully hedge the risks a plan faces. Duration is not an end-target when we craft LDI solutions, but a guidepost. The best solution will typically not have exactly the same duration as the client’s liabilities.
Defined benefit (DB) pension plan sponsors often hear that since corporate bond yields are used to evaluate their liabilities, long credit is a better hedge of those liabilities than long government/credit. But that’s not always the case.
With both the Trump administration and Congress making the passage of corporate tax reform a top priority, how should CFOs position their corporations and corporate finances?
Asset returns essentially matched liability returns in both 2015 and 2016, so that on an LDI basis, the two years’ experience were essentially the same. Yet, asset returns for the two years were vastly different.
Corporate defined-benefit (DB) pension plans came into 2016 hoping for meaningful gains in funded status, but developments thus far suggest otherwise.
In order for corporate bonds to be a successful hedge of Defined Benefit (DB) pension plan liabilities, bond returns must match or exceed those of the liabilities. This makes active management a critical component of any LDI strategy.
Working with our Liability Driven Investing (LDI) Optimizer model over the past 2 years, we have found that the model prescribes substantial allocations to Intermediate Credit at funded status levels of 100% or better.
After declines in funded status in 2014 for most corporate defined-benefit (DB) pension plans, 2015 saw little or no improvement.
A perennial finding of Liability Driven Investing (LDI) is that the risks a defined-benefit (DB) pension plan faces are radically different from those faced by the standard, total-return-minded investor.
Corporate bond yields rose in early 2015, serving to reduce defined-benefit (DB) pension liability valuations and provide some relief to corporate DB plans.
A fundamental finding of LDI analysis is that it doesn't matter whether a plan's asset returns are high or low.
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